A share of profits for shareholders
A share of profits for shareholders
A dividend is the share of profits and retained earnings a company pays out to its shareholders. When a company generates a profit and accumulates retained earnings, those earnings can be either reinvested in the business or paid out to shareholders as a dividend. The annual dividend per share divided by the share price is the dividend yield.
A dividend’s value is determined on a per share basis and is to be paid equally to all shareholders of the same class (i.e. common, preferred, etc.). The payment of a dividend must be approved by the by the board of directors.
When a dividend is declared, it will then be paid on a certain date, known as the payable date.
Steps of how it works:
Below is an example from General Electric (GE)’s 2017 financial statements. As you can see in the screenshot, GE declared a dividend per common share or $0.84 in 2017, $0.93 in 2016, and $0.92 in 2015.
This figure can be compared to Earnings per Share (EPS) from continuing operations and Net Earnings for the same time periods.
There are various types of dividends a company can pay to its shareholders. Below you will find a list and a brief description of the most common types shareholders receive.
Managers of corporations have several types of distributions they can make to the shareholders. The two most common types are dividends and share buybacks. A share buyback is when a company uses cash on the balance sheet to repurchase shares in the open market. This has two effects: (1) it returns cash to shareholders, and (2) it reduces the number of shares outstanding.
The reason to perform share buybacks as an alternative means of returning capital to shareholders is that it can help boost a company’s EPS. By reducing the number of shares outstanding, the denominator in EPS (net earnings / shares outstanding) is reduced and thus EPS increases. Manager of corporations are frequently evaluated on their ability to grow earnings per share, so they may be incentivized to use this strategy.
When a company pays a divided it has no impact on the Enterprise Value of the business. However, it does lower the Equity Value of the business by the value of the dividend that’s paid out.
In financial modeling, it’s important to have a solid understanding of how a divided payment impacts a company’s balance sheet, income statement, and cash flow statement. In CFI’s financial modeling course, you’ll learn how to link the statements together so that any dividends paid flow through all the appropriate accounts.
A well laid out financial model will typically have as assumptions section where any return of capital decisions are contained. For example, if a company is going to pay a cash dividend in 2021 there will be an assumption about what the dollar value will be, which will flow out of retained earnings and through the cash flow statement (investing activities), which will also reduce the cash balance.
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